The Bear Raiseth His Head…

Here’s part II, as promised. This is more of the history behind the market crisis, and why it’s affecting the individual investor positively with concern to munis.

________________________

II. The Bear Raiseth His Head…
The year 2008 saw de-leveraging on a scale that hasn’t been witnessed since the Great Depression. Everyone, from Ma and Pa investors to mutual funds and hedge funds, had to liquidate at an unprecedented rate. Individual investors wanted to keep their money safe, so what did they do? They sold whatever they had - bonds, equities, etc. - as fast as possible in order to escape the calamity of the Bear market. Investors who had their money tied up in larger operations (mutual funds, hedge funds, investment banks, etc.) called up their respective investment entities to demand it back. Faced with these redemption requests, all of these companies were forced to scrounge money from whatever source possible. Money doesn’t grow on trees, so almost all of them ended up having to sell massive volumes of bonds and equities just to meet investor demands (as well as conforming to regulation on part of bond ratings, more on this later). And what, my friends, happens in huge sell-offs?
Prices dive.

Munis, which almost never stray from the 100 mark, have gone down to 90, 85, 80… even 70 cents on the dollar. Let’s look back at the formula:
ACY = [(Coupon ÷ Price) x Face Value] + [(Face Value - Price) ÷ YTM]

See that inverse relationship between yield and current price? We’ll flesh it out later - try not to wet your pants (yet), because things gets even better for you.
Let’s first backtrack a little bit. Take the hypothetical example of a larger investment body that could have survived the stock/bond market massacre through sheer attrition. What if said company wanted to keep some of those bonds? Well, that depends on what the bond rating agencies say.
There are about two or three major bond rating agencies out there, and frankly, they’re all pretty sketchy. I’m not sure what criteria they use to make these market-altering value judgments, but they apparently have the authority to pass out “report cards” to various bonds. The “grades” go something like this: A, AA, B, BB, and so on. Any bond that has a rating lower than BB is considered a “junk” bond.
By charter, large investment entities (mutual funds, hedge funds, investment banks, venture capital bodies, etc.) cannot hold junk bonds. This is the second huge reason why they had to sell a lot of bonds during the economic crisis, and the biggest reason why you should be getting into munis now.
At this moment, everything looks dismal, and ratings are way down - for all bonds, not just munis. Everything looks like “junk.” Plus, it looks bad for any market when big investing firms are showing absolutely no signs of activity. What you now know is that they probably WANT to, but their hands are tied! This is an unbelievable deal in an otherwise compromised economy.

__________________

Part III tomorrow. I know you can’t wait!